Beroni Group: Managing General Partners-Limited Partner Relationships
Group 3
Delivered to: Viney Sawhney, Peter Gianonatti Students: Yi You, Fernando Garcia de Rojas, Pedro Morais, Carolina Pierry, Dennis Pei, Ahmed Idrees
1a) How should Jack Draper deal with allocation of deal flow between the different funds that had overlapping mandates, and/or between one of his current funds and an eventual successor fund? Explain your answer. (There are many optional ways to invest, e.g, BAF II first; BAF III first; proportionately between BAF II and BAF III; discretionary investment-by-investment decision)
Typically, new funds should not be raised unless assets of the previous fund have already been allocated. Although Mr. Draper should first finish investing BAFII, where there is one more year left in the investment period and $135 million left to invest, he will ask both Advisory Committees to co-invest in this attractive deal. He should divide the deal based on the 10% threshold that funds typically have on investment concentration. So that means that up to $35 million should go to BAF II and up to $50 million to BAFIII (using only closed funding and not additional funding). If the deal is smaller than that, he should divide the deal evenly between the two funds, where he will not favor one versus the other. He does not want to upset existing Limited Partners who were with him from the beginning, nor does he want new Limited Partners to think they are not being treated fairly. These decisions should be made on a case by case basis and there should not be any set guidelines on the funds about coinvestment opportunities with other funds. Mr. Draper could also approach Gulf Developments to see if they want to co-invest in the deal outside of BAFII, as they are the only Limited Partners not participating in BAFIII. That way, he keeps his relationship with Gulf Developments and is not perceived in favoring one fund versus the other. 1b) Should allocations be fixed or discretionary? Explain why.
Allocation of funds should be fixed. This is because Private Equity is governed by clearly set guidelines which assist the GPs, LPs and the Advisory committees in arriving at their investment decisions. For example, if a decision is made to invest in a new fund, decisions are made concerning how funds will be allocated to the new investment plan. A strategic guideline is usually set which is followed when allocating resources to a new fund investment. 1c) Regarding the impending deal, which AC should he approach first? Explain why.
In relation to the impending deal, Jack Draper should approach the BAF II advisory committee first. This is because it is the mandate of the committee to oversee success ending of the BAF II investment and also ensure that all LPs who had fully committed to the fund are fully paid their shareholding value before another fund is established. Profits gained from the fund should also be shared according to the agreed guidelines before the fund is terminated and LPs establish a new fund (Acharya, 2013).
1d) In addition to approaching one of the ACs first, with what sort of proposal should he present to that AC in order to minimize potential tension among the differentlyinvested LPs?
In regard to approaching one of the advisory committees first, Jack Draper should approach the committee with proposal concerning withdraw of one of their key LP, Gulf Developments. He should discuss with the advisory committee implications of the withdrawal and how it will directly affect BAF II. In his proposal, Jack Draper should give suggestions on what the advisory committee should consider in order for a successful liquidation of the BAF II. In case the advisory committee sees it not fit to dissolve the fund, they should be at free will to give strategies which should be used in ensuring that LPs’ withdrawal does not have a negative impact on the fund. 2a) How should Jack Draper deal with downward pressure on his management fees as more assets came under management?
Jack Draper could lower his costs and provide his clients with lower fees as his team that has been working on acquiring new investments will shrink its work hours and work load on BAF II. He can cut back on some stuff that was needed when the AUM was at its peak. With lower AUM the required work and the required staff can be significantly reduced. If Jack Draper wanted to keep his team what he could do is make them start working on his new fund BAF III. This way the fees will be lowered in his BAF II, which would please the limited partners. With the reduction of fees, the limited partners will be return investors with The Beroni Group, as they know he has their best interests in mind. It will show that it makes sense to lower management fees as AUM gets lowered and Jack understands that and is willing to accept and accommodate lowering fees. Also by Jack putting his team to work on the BAF III fund he can continue to pay his team and the investors in that fund will be accepting of that. By doing this Jack will also be able to provide better returns for his clients, as the money that is saved from the management fees will be put back into the client’s pocket. 2b) Since some costs were fairly steady regardless of how much capital is under management (such as rental costs, back office staff, etc.), how could he reject investor demands to lower management fees?
If costs have been fairly the same as throughout the fund and all the back staff is needed Jack can take the route of rejecting the management cuts. What Jack Draper can say to his clients is that the management fees were placed in the beginning of the fund as the costs of labor, rent, and backroom staff fees were accounted for and will be kept for the fund to be run smoothly. What Jack can also do is let investors know that the even though the assets under management have decreased the assets that are still being managed need to be managed well for them to have a good return. If they start neglecting the remaining assets that are being
managed to save money they can have a bigger loss at the end of the when they will need to liquidate the remaining assets. This will stop the limited partners, as they would not want to risk neglecting the assets they have and would rather pay fees now and have a bigger return when the fund has closed. 3) Since the senior Beroni Group principals served on the deal teams and Advisory Committees of more than one fund, how could he help his investors feel comfortable that the principals (and staff) would allocate their time appropriately between the respective funds?
Beroni Group principals served on more than one team and advisory committees and investors have fear that they might be incompetent in managing their funds. In dealing with this doubt, Jack Draper should give prior successful funds which the principals have managed in the past. The investors should be informed that those principals managed those funds using managerial skills of that time and yet emerged successful (Huther, 2015). In the recent fund investments, the same principals have participated in more than one fund and achieved successful projects. In comparison with the projects they have been managing, investors should have confidence in them that they will do an excellent job. 4) How could Jack Draper help his investors get comfortable with the prospect of de facto cross- liability – that is, if one of his funds were to run into difficulty, how could he “ring fence” other unrelated funds to ensure there were no negative financial or time effects on the GP and the managers? The concerns are: Cross-liability if one of his funds were to run into difficulty, that could result in a negative financial effect on the other funds Staff’s attention to their investments is being compromised because of the other funds.
In ensuring that investors get comfortable with the prospect of de facto cross-liability, Jack Draper should ensure that all fund investments have a defined expiration period. It should be ensured that information concerning the timelines of different fund investments is communicated with transparency. Also any fund faces financial crises should be shared with the investors so that they get to know how the investments are performing. Guidelines could also be established to safeguard any fund which faces financial distress. The guidelines should provide solutions and alternatives on what should be done in ensuring that resources can be transferred from one fund to another without reducing the value of either fund. 5a) How could Jack balance the needs and requests of EuroBank, one of his oldest and largest investors, with the quite legitimate expectation of other LPs in BAF II and BAF III that EuroBank not be shown favoritism, and that a portion of EuroBanks’s interest be forfeited and distributed to them?
Jack should balance the needs and requests of Euro bank by examining the interests of the investors. Decisions made in relation with strategies to be undertaken by the Euro Bank should be those which address interest’s majority of the investors. In the case where the needs and requests of the Euro Bank do not seem to address interests of the majority of investors, Jack should seek opinion of the majority of the LPs together with their principals who should assist in arriving at a decision which is fair to everyone. 5b) Would he be faced with a flood of defaults and withdrawal requests if he were to treat EuroBank gently?
Yes, Jack Draper would be faced with a flood of defaults and withdraw requests if he treated the Euro Bank issues gently. This is because the fund had full support and commitment of its LPs and investors and any action to alter their investment would be received negatively. Also most of the LPs disliked each other and in case of any issue affecting their investment would explode causing some members to withdraw their investment commitment and hence lead to the downfall of the fund (Sorensen, 2014). 5c) What fiduciary duty did he owe to the non-defaulting LPs in BAFII and BAFIII that had apparently managed their finances more prudently than EuroBank?
Jack Draper owed to the non-defaulting LPs in BAF II and BAF III right to ensure that their funds were well managed. He himself was liable for any action that would negatively affect their interests. He should therefore ensure that in any action undertaken, interests of LPs are withheld upright. 5d) Would the GPs risk breaching the limited partner agreements to implement EuroBanks’s proposal? (Page 2 of the case states, GPs of BAF II have some discretion over enforcement of the forfeiture provision)
Yes, It would be GPs’ risk of breaching the LPs agreements if Euro Bank’s proposal was implemented. The Euro Bank’s proposal had not been incorporated in the Limited Partnerships agreements. It therefore did not have any right to be implemented. In case where Euro Bank’s proposal was the only solution available to secure LP’s funds, it would have been mandatory that the limited partner agreements would be corrected in order to provide a clause which would allow the Euro Bank proposal to be implemented. No clause existed and therefore implementing Euro Bank’s proposal would be a direct breach of the limited partner’s agreements.
REFERENCES:
Acharya, V. V. (2013). Corporate governance and value creation: Evidence from private equity. Review of Financial Studies, , 26(2), 368-402. Huther, N. R.-W. (2015). Paying for performance in private equity: evidence from management contracts. Duke University. Sensoy, B. A. (2014). Limited partner performance and the maturing of the private equity industry. Journal of Financial Economics, , 112(3), 320-343. Sorensen, M. W. (2014). Valuing private equity. Review of Financial Studies, , 27(7), 1977-2021.
